In my conversation with Ian Walsh, who is a partner at a private real estate, asset-based lending company that specializes in underwriting and evaluating residential investment properties, he provided tips for the fix-and-flipper that wants to run a successful real estate business. Ian provided tips on how he approves loans for fix-and-flippers, two factors that end up in borrowers not getting a loan, and two tips for managing the construction costs.
Asset-Based Lender’s Approval Process
The main advantage Ian and other private, asset-based lenders have over traditional banks is that asset-based lenders do not require w2’s, tax returns, bank statements, or any other financial documentation on the borrow. They loan solely on the basis of the asset. For Ian’s business, if a fix-and-flipper has a deal and wants a loan, all they have to do is email or call Ian and provide three pieces of information:
- What is the property’s address?
- What are the construction costs that will bring the property up to the resale value?
- How much will the property be purchased for?
With these three pieces of information, Ian is able to underwrite the property, shoot them a number back, and see if it works for them. If they say yes, then Ian will precede with preparations for closing.
The number Ian “shoots back” is the maximum amount of money he is willing to loan, which is typically 65% of the after-repair value (ARV). For example, if the ARV is $200,000, then Ian is willing to loan up to $130,000. However, Ian wants to see the borrower’s skin in the game, so asset-based lenders typically won’t provide zero money down loans. Following the $200,000 ARV example, if the property is under contract for $70,000, the construction costs are $40,000, and the closing costs are $20,000, which brings the all in price to $130,000, Ian would only provide a loan of $110,000 and ask the borrower to bring the additional $20,000 to the table.
Having the borrower put their skin in the game, as well as having equity in position is how asset-based lenders are able to offset their risk. In return, personally having a low credit score, high debt-to-income ratio, etc. won’t disqualify you. However, if you have a disconcerting personal financial situation, like a 300 credit score, the asset-based lender will offset their risk by asking for a larger down payment. For example, for an individual with a 300 credit score, Ian would have no problem loaning $100,000 on a $1 million project, but wouldn’t provide 65%, unless the borrower brought on a co-signer, put up collateral, or provided some other source to buffer out the lender’s risk.
After Ian has underwritten the property, provided you with the loan amount, and you are okay with the numbers, then the only steps between you and closing (in most situations) is reviewing an EUF (estimated use of funds) that shows you the breakdown of costs and how much you need to bring to the closing table, and the LOI (letter of intent) that states that the lender is going to fund the deal.
Two Factors that Disqualify Deals
- Not Actually a Deal – The majority of deals that Ian passes on are ones that aren’t actually deals. An investor will present a deal that they think is a deal, but when Ian underwrites it, he sees that it is not a deal at all. Therefore, to avoid these types of situations, you have to understand your numbers. You have to know that you are looking at a deal without guessing or using information that you obtained from Zillow. The information on sites likes Zillow is inaccurate, so you need to have access to the MLS to get the real detailed property and sales information. If you call Ian and say that a property will resale for $300,000, and he underwrites the ARV at $200,000, then he knows that he is working with an investor that doesn’t know what he is talking about. However, as long as you are within 10% of Ian’s number, he is willing to work with you to make the loan happen.
- Incorrect Construction Costs – Construction costs make or break the deal. Ian has seen deals that are amazing on paper get knocked down to nothing due to incorrect construction budgets or the mismanagement of contractors. Therefore, you really have to manage your contractors, know your contractors, and take the time to vet your contractors. And when you find solid contractors, you have to do whatever it takes to keep them happy.
Two Tips to Calculate Construction Costs
- Don’t Get Your Money Ahead of the Contractor – If you give a contractor $4,000 and they have only done $2,000 worth of work, assume that they are going to disappear and that your $2,000 is gone. You never want to be in the position where you are going to lose money because you paid a contractor too much in advance. Many of the fix-and-flippers that Ian works with will only pay upfront for the materials and then have an agreement to pay the labor costs upon completion.
- Always Build a Buffer – As a fix-and-flipper, you will almost always face a situation where you knock down a wall and find an issue that you didn’t anticipate, which is why it is vital that you build a buffer into your construction budget. If you are wrong and everything goes according to plan, then you make more money. If you are right, then you anticipated it, budgeted for it, and are in the clear. However, if you didn’t anticipate it, you are losing money, and you might as well have paid more money for the property.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.